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October 13, 2008

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Mike Woodhouse

"It gives us a breathing space to ask"

Well, yes, but we're not the individuals or organisations who are actually in a position to effect change.

Those that are will probably already believe they've solved the problem, rather than admit that all they've done so far is to partially identify it.

tolkein

But the example of HSBC shows that - so far - shareholders can ensure a very large privately owned bank can do nicely, thank you. I think there does need to be a review (inquiry, witch-hunt, lynching) of the behaviour of the UK banks which got into this mess. And I suspect that you'll find it was the quality of management which was the chief culprit. Nat West had a terrible reputation before being bought by RBS, which itself was no great shakes.

I think that the FSA needs to ensure that remuneration structures are better aligned with shareholders long term interests, and this is fair as in the end we are likely to have to foot the bill when remuneration structures go wrong.

passer by

Its a simple Principle Agent Problem, Risk should not be shared as it has been by pseudo scientific financial risk models.

Tom A

Markets aren't perfect, especially markets where the people in charge have incentives to take huge risks without any fear of retribution because of the way their rewards are earned, but surely here it's more a failure of suitable regulation and a need to correct that than all these debates about different "isms". Far as I can see it, the Government just wants to get banks back into private hands but in a better regulated market and hopefully make a tidy profit for the taxpayer whilst they're doing it a la the Swedes a few years back.

Mark Wadsworth

Er, the Labour government was complicit in this whole mess.

The whole Nulab 'economic miracle' was based on ever-increasing house prices. You need loads of cheap credit to kick start it (from China, Japan etc) and then the bubble becomes self-sustaining. House price bubbles and credit bubbles are two sides of the same coin.

Sure, a lot of people made a lot of easy money from property or bonuses on persuading people to take out ridiculous mortgages and then selling them on as 'mortgage backed securities'. But the government was perfectly aware of all this and did not take the three simple steps to prevent it, i.e. liberalise planning laws; replace a shed load of existing taxes with Land Value Tax and have sensible banking supervision. NR was lending 6 times income, FFS!

And those 'greedy bankers' and 'selfish BTLers' (me included, so there!) were just playing the rules that the government laid down.

Which is not to say that things wouldn't have been just as bad under the Tories, of course. And Tories, the NIMBY party will not in a million years implemenet these three simple steps, and so people will do exactly the same thing again in five or ten years' time (me included, so there!).

dearieme

"in complex organisms ... fragmented and tacit knowledge cannot be centralized, and “leadership“ often degenerates into mere rent-seeking." Very well said. That's the kybosh on socialism, then.

David Heigham

Interesting, if before its time. Consider:

- Commercial banks used to be de facto quasi-federations; the key information about the clients resided in the branches. That did not prevent financial crises. Credit scoring, etc., has centralised much key information and strengthened the heirarchy. Has this increased or decreased systematic risk?

- Savings and Loans, Building Societies, and similar mutual or co-operative banks were and are vulnerable to mangement stupidity and chronic inefficiency. (Those still surviving have done better than most). They pose less systematic risk of generating crises than do commercial banks, but still can produce painful and costly episodes. What is the trade-off as against the characteristics of commercial banks?

- The key agent:principal problem in commercial banks appears to be that the mangers of the enterprise share the profits but leave the losses to the shareholders (and creditors). This is an incentive towards accepting risk and its accompanying likelihood of profits on most occasions. However, when banks were unlimited liability partnerships, banks gave rise to at least as much systematic risk, and were notoriously vulnerable to greedy behaviour by the partners. More symetrical rewards for those in charge is no panacea.

- The sytematic risks in publically owned banks are politically driven mis-use of funds and lack of resistance to cost pressures. How much of these is it worth accepting for avoidance of risk of financial crises?

- Banks which are subsidiaries of other commercial organisations are at risk of having depositors' interests subordinated to those of the parent organisation (much as with publically owned banks). They are likley to be marginally more risk-averse than commercial banks for that very reason.

The forms of organisation of banks that have been tried so far appear to offer no escape from the regulatory problem. However, might regulation be easier to manage if it were an objective of policy to maintain competition between differently organised banks each subject to its own balance of types of risk? That is to say not just an oligopoly of the "big five" (or now three?), but HSBC v Llloyds v Abbey Santander v Nationwide v Co-op Bank v Tesco Bank v (perhaps) People's Bank of Britain v etc.?

Gavin Hinks

Very interested in the complex organisations observation. Surely that means we have to question, not only ownership, but also the activities undertaken by banks. The question is whether everything they do should be undertaken by a single organisation?

Luis Enrique

I'm not sure about this ... if part of the problem was an information/confidence based market failure, information cascade, type of thing, then a bit of central planning - some command and control - can be just the ticket. So perhaps there is a role for some central planning in the financial sector.

Likewise, if some of the behaviour that was behind this problem is of the sort that's individually rational but collectively dangerous, it's not obvious to me that individual organizations that happen to be, say, worker owned, are going to be any less prone to it. I suppose I don't really follow your argument that connects the kind of mistake that were made (not that I know what you think they were) to the ownership structure, and why different ownership structures would have done things differently.

There are many candidate stories for precisely which 'bets' made with with financial instruments are responsible for the crisis, but Brad Setser relates on such 'mistake' here -

http://blogs.cfr.org/setser/2008/10/12/on-the-precipice/

banks had built their practices on the assumption that default risk was smaller than it actually was. Never mind whether that story holds water or not - but for the sake of argument, how would a different ownership structure not have made that mistake?

Luis Enrique

I'm not sure about this ... if part of the problem was an information/confidence based market failure, information cascade, type of thing, then a bit of central planning - some command and control - can be just the ticket. So perhaps there is a role for some central planning in the financial sector.

Likewise, if some of the behaviour that was behind this problem is of the sort that's individually rational but collectively dangerous, it's not obvious to me that individual organizations that happen to be, say, worker owned, are going to be any less prone to it. I suppose I don't really follow your argument that connects the kind of mistake that were made (not that I know what you think they were) to the ownership structure, and why different ownership structures would have done things differently.

There are many candidate stories for precisely which 'bets' made with with financial instruments are responsible for the crisis, but Brad Setser relates on such 'mistake' here -

http://blogs.cfr.org/setser/2008/10/12/on-the-precipice/

banks had built their practices on the assumption that default risk was smaller than it actually was. Never mind whether that story holds water or not - but for the sake of argument, how would a different ownership structure not have made that mistake?

Bob B

The stockmarket prices of those UK banks which are not taking state-aids seem to be doing well:
http://newsvote.bbc.co.uk/1/shared/fds/hi/business/market_data/shares/3/498/0/default.stm

passer by

Yes bob b, the cancer is now exposed and in the spotlight.

Bob B

Georges - It's absolutely relevant. Thanks for that.

Juan

Very nice post.

Key sentence: The lesson of the collapse of many banks is that centrally planned companies are also a bad idea.

Which can be thought of in the form of a contradiction between the necessarily planless outside world and the internal corporate plan with its struggle to control what it cannot, a contradiction that can drive both greater internal asymmetries and centralization thus providing illusions of 'a tight ship' even as it is blowing bulkheads and in process of sinking.

jameshigham

Have no fear, Chris - you'll get your total nationalization by 2015.

Chris Williams

I want my financial service institutions to be big enough so that they can afford to cock up on one big investment (£20million) every ten years, but no bigger. Total assets and liabilities of about half a billion seems about right. That would equate to one building society for each of the thirty or so biggest cities in the UK, plus a few extra for London, Manchester, and Birmingham.

They need to be small enough to be allowed to fail: also we need to work out ways of promoting a steady stream of new ones to fill gaps of the casualties.

Adam

Given that the first action of the newly nationalised Icelandic banks was to default on its debts to UK depositors, I think the issue may be a bit more complex than plc bad, nationalised good.

You're also ignoring the hundreds of banks worldwide which were managed prudently enough to survive.

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